Considering A Lease?

Chiropractic EconomicsDecember 29, 1998

Thinking of leasing medical equipment and office furniture? Whether you’re launching, expanding or enhancing your practice, you’ll be faced with some tough financial decisions. Acquiring practice and office equipment and furniture is challenging even to a business-minded DC. You must decide whether to purchase outright, lease for a specified number of years or finance via an installment purchase. You need to understand the features, benefits and even the disadvantages of each type of financing. Then you must select a lender who understands your needs. These matters are not usually part of the chiropractic college curriculum.

The following guide to equipment acquisition will make the process simpler and help you make educated decisions. Keep in mind you make money when you use equipment. You need not own the equipment to receive the benefits of its use. This is the principal argument for leasing-plus the fact that your monthly lease payments are usually tax-deductible, like rent. By leasing you don’t draw-down capital and may be in a better position to take advantage of technological changes and thus avoid being trapped by obsolescence.

When you purchase equipment-whether by an outright investment or installment financing, in 1998 you are able to expense up to $18,500 of the cost of the new equipment placed in service during the year. This deduction rises gradually until it reaches $25,000 in 2002. The remaining cost is depreciated over the equipment’s tax life.

When you purchase rather than lease, you own the equipment from the start, but you are depleting your working capital and reducing cash flow. This can leave your practice vulnerable to the whims of the economy. It can also prevent you from taking advantage of opportunities because you lack liquidity. It may be more beneficial to use your discretionary income to fund your pension plan, rather than for the purchase of equipment.

1. Leasing/Financing vs. Buying

Will you lease/finance office furniture and medical equipment or will you buy? Both leasing and buying have merits and drawbacks.

Buying with your own funds requires digging into your capital, depletes cash flow and can be most costly in the end when you calculate the opportunity cost of the purchase.

Leasing is a popular choice among health care providers. This makes it possible to pay for equipment from current production, rather than past earnings. Thus, leasing is attractive to small or private practices.

For the small practice, it makes sense to lease expensive items such as chiropractic tables and x-ray machines. Less expensive instruments and pieces of equipment (costing under $500) are good candidates for purchase.

Medical and office equipment is constantly upgraded to meet increasingly stringent professional standards and requires routine replacement for a practice to remain up-to-date. While state-of-the-art equipment is imperative for modern practices, it will eventually need to be replaced and reselling outdated equipment is nearly impossible.

In the past, when health care providers leased or financed equipment instead of buying outright, it often meant they had bad credit. This is not the case today, as many smart business people see that leasing or installment financing offers substantial tax benefits. Leased equipment, listed as an expense on your income statement (as opposed to an asset, like the equipment you own) is usually tax-deductible. One exception to this rule, however, involves the relatively new tax law, IRS Section 179. Section 179 gives small business owners a break in that it allows them to deduct up to $18,500 (in 1998) of business asset purchases as current expenses. This allows for an immediate write-off of capital assets. So depending on the amount of equipment you need, whether you lease, finance or buy depends on the cost of the equipment. Your accountant will advise you on this issue.

2. Evaluate the lender.

An external lender with experience financing practices like yours will put costs in perspective and will also help you be more productive in your practice.

You’ll need extra attention in the early stages of financing your practice and will want to work with a qualified finance company.

There are several questions you should ask to evaluate whether the finance company has the experience necessary to guide you through tough financial decisions:

Does the finance company lend exclusively to health care professionals? A lender that focuses on the health care industry will be able to look beyond traditional risk models and work with practices whose size or financial history limits their access to large lenders.

How long has the company been in business?

How many customers has it financed? A company that has seen thousands of doctors through challenging financial situations is uniquely qualified to respond to the very specific needs of health care providers.

Is the company national in scope? A company’s growth indicates success. Regional companies may not have as broad a range of vendor and bank relationships.

Does the company provide financial resources and consulting services? Financial services companies that specialize in working with health care practices understand the competing demands of cash flow and growth and will work with even the smallest ventures.

3. What should you look for in a leasing/ financing company?

The company must have a specific focus on the health care industry, the ability to be your partner for the long-term, attentiveness to your needs, an experienced sales staff, efficient customer service and ongoing relationships with the top vendors in the industry.

A company that keeps you looking ahead, knows what new equipment is coming into the market, possesses specialized knowledge of the financing and equipment needs of chiropractors and will remain focused on your best interests. After all, an investment in your future is an investment in their future.

A company that is a “one-stop shop” and meets your practice’s needs for equipment, furniture, working capital and leasehold improvements will save time and headaches in the long run.

The company must be able to offer a clean contract­­a straightforward agreement without any hidden clauses.

4. What does a leasing/financing company look for?

Equipment manufacturers that sell and finance their products, leasing/financing subsidiaries of national and regional commercial banks and other leasing and finance companies compete for the business of the health care professional. When doctor specialists such as chiropractors want to directly acquire relatively inexpensive equipment of $50,000 or less (i.e., they accept full financial liability), lenders generally can make credit decisions based on financial statements or tax returns. However, many banks and finance companies are not willing to make loans of $50,000 or less to medical specialists based solely on their personal worth and additional collateral, such as a house.

5. Leasing lingo.

As you evaluate your financing options, it is important to focus on terms, not price. Two x-ray machines may have the same purchase price, but considerations such as interest payments, make/model, etc., may make one a much better value for your money. Keep the same thing in mind when you shop for a lease.

A typical lease for an installment financial transaction for medical equipment lasts 3-5 years.

Lease documentation varies widely between lessors. Some terms and conditions are absolutely mandatory, but others are optional and negotiable. A lease should include purchase add-on options.

Traditionally medical equipment leases have had original terms of 3-7 years, with five years being the most common.

Generally, the leases are “triple net” leases in that the lessee is responsible for equipment maintenance, insurance and taxes.

Most leases call for level payments during their term, usually on a monthly basis.

A “buck out” or “dollar out” capital lease transfers title to the lessee for a final payment of one dollar.

Virtually all equipment financing is structured on a fixed interest rate basis and is becoming more popular as a method of payment. As always, check with your accountant.

In general, be sure that the terms the lender establishes for you reflect not only your immediate requirements, but your long-term goals and growth plan as well.

6. Types of leases.

Capital leases are those that meet the accounting criteria for “capitalizing” an asset on the doctor’s balance sheet. Capital leases are the same as debt and are carried on the balance sheet as a liability, with the equipment shown as an asset; i.e., dollar buying out leases.

Operating leases are those that do not meet any of the criteria of the capital lease and therefore are not recorded on the balance sheet. Note that an operating lease is considered an expense item on the income statement. Operating leases are best used to finance assets with short useful lives (3-7 years).

7. The contract agreement.

When the doctor (the lessee) enters into an agreement with a leasing company (the lessor), the doctor provides the exact equipment specifications to the company, which purchases the equipment from the manufacturer.

Usually, the leasing company takes an assignment of the doctor’s purchase order. This protects the relationship between the doctor and the manufacturer of the equipment.

The doctor is responsible for arranging a maintenance agreement with either the manufacturer or a third-party maintenance organization.

The lessee must also carry liability insurance on the equipment, as well as insurance covering the value of the equipment against casualty or loss.

Over the lease term, the lessee makes fixed payments to the leasing firm, usually monthly.

Many leasing companies can support their customers with value-added services, such as the financing of add-ons and upgrades and strategies for future equipment needs.

At the end of the lease/finance you have three options:

Return the equipment to the lessor.

Renew the lease for an additional amount of time (usually at reduced rates).

Buy the equipment outright as used equipment, usually at 10% of its original cost.

8. The bottom line.

The leasing/financing process, although challenging, has the potential to be a rewarding financial experience­­especially now that you have a clue as to the “ins and outs” of leasing and financing. After the administrative details are taken care of, you’ll be able to focus on what you do best: delivering top-quality chiropractic services to your patients.

This article includes information obtained in a survey conducted by Marketdata Enterprises, Inc. published in December, 1997.